Shareholders of the once high-flyer Netflix (NASDAQ:NFLX) have experienced quite a roller-coaster ride. Over the last year, the stock peaked at $300 then dropped as low as $62 before recovering to $110. Netflix, the scrappy competitor, has built its brand through its brilliant disruption of the entertainment distribution business model over the last decade.
Act I: First-Mover in Online Streaming
Over the years, Netflix successfully fended off challenges from brick-and-mortars, such as Blockbuster, and disruptors, such as Red Box, by pairing its DVD-rental business with unlimited streaming. The online streaming model turned out to be a great catalyst for the shares for a number of years. As a pioneer of online streaming, Netflix was able to negotiate good deals with content providers and set-top-box distributors Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT). The rest is history, as streaming created longer and stickier customers.
Ironically, Netflix's extraordinary success in online streaming has attracted the attention of well-capitalized competitors and, importantly, the content providers themselves. Had it not experienced such explosive growth, Netflix may have been able to secure longer-term content contracts at the teaser rate of $0.15/subscriber that it had earlier negotiated with a number of studios. But Netflix's stock soared from $30 to $300. As a result, the big boys in the online world took notice.
The Problem: Attracting Goliath's Attention
What is Netflix's Act II? There are large-cap competitors from all sides vying for a piece of Netflix's streaming business. Compare Netflix's current $7.99/month online streaming plan to other offerings. Amazon (NASDAQ:AMZN) offers free streaming to its Prime customers. The Prime subscription has a compelling value proposition: for a $79 annual subscription, members receive a valuable bundle of free shipping, cloud services, access to Kindle books, and unlimited streaming. On the DVD side, Coinstar (NASDAQ:CSTR) has the omni-present and convenient RedBox kiosks which provide the latest rentals for $1 a day.
Recently, the 800-pound gorilla, Comcast (NASDAQ:CMCSA), has entered with a Streampix unlimited streaming option; for a mere $4.99/month, subscribers receive unlimited streaming of a wide collection of shows. Comcast's entry is troubling, as they are a well-capitalized volume purchaser that can negotiate much better streaming contracts with content providers than Coinstar. Oh, by the way, recall that Comcast also provides on-demand movies and internet. It owns big-3 content provider NBC. Comcast presents Netflix with its most fierce challenge yet.
Act II: Partner or Merge
The writing is on the wall; the emperor has no clothes. I do not see how Netflix can be viable as a stand-alone company with these large competitors encroaching on its turf. Comcast is to Netflix as Wal-Mart is to a local mom-and-pop store. When it enters town, Wal-Mart is able to offer the lowest prices because it is the largest-volume purchaser. Similarly, Comcast and Amazon have more negotiating leverage with the studios.
While it was dramatically successful in growing its subscriber base, Netflix has been unable to secure long-term streaming contracts at a reasonable price. Netflix will need to partner with a major studio, or perhaps merge with either a content provider or distributor. Netflix has many valuable attributes: a strong brand, loyal subscriber base, and valuable predictive analytics technology. All of these will be valuable to a suitor. To maximize shareholder value, Netflix should consider merging with a content provider or content distributor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.